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Do Interest Groups Unduly
Influence Bank Regulation?
The view that dominates in a country will determine
whether government leaders and regulatory officials
choose those bank regulations that work best, or those
that contribute to a less efficient and stable banking
industry.
James R. Barth1
Apanard (Penny) Prabha2 and
Wenling Lu3
Of course, special interest groups, such as financial
firms and consumer organizations, play an important
role in the process by trying to influence the policies that
are chosen. Some groups may lobby and provide campaign contributions to policymakers seeking preferential treatment for their narrow special interests, which
tilts the balance towards the private interest view. For
example, some existing banks will have an incentive to
lobby in favor of regulatory policies that limit competition, such as those restricting the entry of new banks.
As another example, some troubled banks will have an
incentive to seek regulatory policies that grant them
forbearance even as they compete in ways that may adversely affect other healthy banks. By contrast, other
groups may provide useful information to policymakers
that can lead to regulations allowing the introduction of
new and innovative financial instruments that promote
social welfare, which is consistent with the public interest view. For example, when savings and loans were
devastated by interest rate increases in the late 1970s
and early 1980s they successfully lobbied for permission to offer variable-rate mortgages and use derivative
instruments to hedge their interest rate risk. In short,
given the critical role played by banks in determining
who gains access to funding and who does not, organized interest groups will surely devote substantial effort
to shape national banking policies.
Introduction
It is well known that banks in countries around the
world play a key role in allocating resources that are essential to economic growth and development. It is also
well known that banks do not always allocate resources
to the most productive projects based on both risk and
return considerations. This was the case during the recent global financial crisis when some banks engaged
in such excessively risky and less productive activities
that they either failed or were bailed out. The severity of
the crisis underscores the need for governments to put in
place bank regulatory regimes that prevent such deplorable episodes.
What may be less well known is that even if governments know what works best to ensure safer and sounder banking systems, it does not follow that they will pass
laws and implement regulations consistent with that
knowledge. The reason is that governments may simply
choose policies that cater to their own private interests,
rather than those that promote the public interest. In
short, there are two different views of the type of regulatory regime that may exist in countries. One view,
the private-interest view, is that governments will shape
bank regulations so as to enrich and protect their interests. The other view, the public-interest view, is that governments will provide regulators with sufficient power
to effectively curtail excessive risk-taking by banks
so that they behave in a socially beneficial manner.
The purpose of our article is to discuss the private- and
public-interest views of regulation. We will also briefly
discuss the types of regulations that work best to promote well-functioning banking systems and the type
of factors that either lead or do not lead countries to
implement such regulations. As will be seen, it is the
existence of certain political and institutional characteristics in countries that are likely to lead to the adoption
of the public-interest view, rather than the private-interest view of regulation. It is therefore the extent to which
these political and institutional characteristics exist in
countries that will determine the degree to which spe-
1
Auburn University, Milken Institute and Wharton Financial
Institutions Center.
2
Milken Institute.
3
Washington State University.
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CESifo DICE Report 4/2013 (December)
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cial interest groups will be able to exert undue influence
on government leaders and regulatory officials to favor
narrow special interests rather than the broader public
interests.
incumbent institutions. Furthermore Barth, Caprio and
Levine (2006) empirically show that, despite evidence
that private monitoring promotes better functioning
banking systems, not all countries adopt such a regulatory policy.
Private- vs. public-interest views of bank regulation4
More generally, there is a growing body of other research that focuses on how interest groups use lobbying
to exert a disproportionate impact on public policies so
as to benefit themselves. In the case of the United States,
Figure 1 shows the annual amount spent on lobbying
by the financial sector and the corresponding amount
of spending by just commercial banks over the period
1998 to 2012. It is quite clear that the amounts spent in
both cases increased considerably over the past decade.
Specifically, the amount spent by financial institutions,
insurance companies, and real estate firms increased to
USD 488 million in 2012 from USD 214 million in 1999,
or 128 percent, while for commercial banks the amount
increased to USD 62 million from USD 22 million over
the same period, or 178 percent. It is quite interesting
that the biggest year-over-year increases in spending occurred shortly before and continued to increase during
the financial crisis, the government’s support of a large
number of financial firms under the Troubled Asset
Relief Program (TARP) in October 2008, and the passage and subsequent implementation of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the
Dodd-Frank Act) in July 2010. With respect to the crisis, research indicates that the pressure exerted on the
government by special interest groups played an important role in the rise and collapse of the mortgage market
(for example, Mian, Sufi and Trebbi 2010a, 2010b; Igan,
Mishra and Tressel 2012). In addition, Angkinand and
Willett (2008) find strong support that certain characteristics of political institutions play an important role
in affecting governments’ abilities to reduce the costs
of 45 banking crises in 27 countries by limiting undue
influence of interest groups. Furthermore, Hardy (2006)
argues that in the event of a large negative shock, the
banks may succeed in obtaining forbearance and a loosening of regulations.
The private- and public-views lead to two diametrically
opposed outcomes with respect to bank regulation. If
the private-interest view dominates in a country, it will
lead to less efficiency in the banking sector and increase
the likelihood of banking system fragility. In contrast, if
the public-interest view dominates, it will lead to more
efficiency in the banking sector and decrease the likelihood of banking system fragility. These two views
fit into an important body of literature that examines
whether and how some interest groups in a country use
the coercive power of the government to extract rents
from others within society (for example, Stigler 1971;
Peltzman 1976, 1989; Becker 1983). The public choice
literature in particular holds that interest groups that
significantly benefit from specific policies being chosen
are better able to organize politically to support those
policies than society at large is able to organize to defeat the same policies if they produce socially inefficient
outcomes. Furthermore, Baron (1994) and Grossman
and Helpman (2001) stress that when the general voting
public has incomplete information about public policies
and their outcomes, this increases the effectiveness of
well-organized interest groups.
There is a growing body of evidence that finds that interest groups can exert sufficient influence so as to help
explain both the enactment and elimination of bank
regulations. For example, researchers document that the
comparative political power of small banks relative to
large banks – rather than broader public interest considerations – has shaped regulatory restrictions on branching in the United States. Other research notes that some
regulations influence small firms differently from large
firms and stresses that the comparative power of these
different interest groups influences regulatory policies
(for example, Kroszner and Strahan 1998, 1999, 2001).
In addition, Laeven (2004) shows that deposit insurance policies around the world are more consistent with
the private-interest view than the public-interest view.
Moreover, Hardy (2006) argues that differences in the
regulatory regime across jurisdictions may persist because each adapts its regulations to suit its dominant
As regards TARP, Blau, Brough and Thomas (2013) find
that the financial firms that lobbied or had other types of
political connections were more likely to receive TARP
funds. Indeed, they report that for every dollar spent on
lobbying, financial firms received between USD 486
and USD 586 in TARP support. In addition, Gibson and
Padovani (2011) find that banks are more likely to lobby when they are larger, have more vulnerable balance
sheets, are less creditworthy, and have more diversified
4
This section draws heavily upon Chapter 5 in Barth, Caprio and
Levine (2006).
CESifo DICE Report 4/2013 (December)
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Figure 1
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
the public of insight into
how rules are being writAnnual amount spent on lobbying by financial and commercial
ten and makes it harder
banks
for Congress and others
Commercial banks
Financial sectora)
to hold them accountable
$ millions
$ millions
600
80
for their decisions.” At
488
the same time, however,
62
60
many big banks, both do400
mestic and foreign, are
40
able to meet privately with
200
the Fed. Table 1 shows the
20
number of such meetings
0
with selected big banks
0
from 2010 to September
2013. These types of
a) Financial institutions, insurance companies and real estate firms.
meetings certainly proSource: Center for Responsive Politics.
vide an opportunity for
this particular group of
banks to try to influence
the leniency or stringency of the regulations that are
business profiles. Lobbying has also been found to afeventually implemented.
fect legislative outcomes. For example, Igan and Mishra
(2011) report that lobbying expenditures by the financial
industry were directly associated with how legislators
Interest groups, political institutions, and bank
voted on key bills before the crisis, and that bills proposregulatory regimes
ing regulation that the industry considered unfavorable
were far less likely to pass than bills proposing financial
Acemoglu, Johnson and Robinson’s (2001) provide a
deregulation. However, they did indicate that it is hard to
useful analytical framework to help understand the
identify exactly what drove the financial industry’s lobemergence of political institutions and their relationship
bying efforts. If it was to promote rent-seeking activities
to the emergence of bank regulatory regimes. Using
they consider it socially undesirable, while if it was to
this framework Barth et al. (2006) argue that political
offer information to policymakers and to promote innoinstitutions help understand cross-country differences
vation they consider it socially beneficial. Importantly,
in bank regulatory policies. In particular, they point out
the fact that lobbying and campaign contributions exist
that the ability of interest groups to influence policies
in a country does not necessarily mean that that country
and promote their own interests depends on the political
is dominated by the private-interest view. It may be that
system. Some political systems discourage transparenthey do, however, tilt the balance somewhat toward the
cy, participation, and competition. Indeed, as they note,
private-interest view insofar as there is a spectrum of
some political systems are controlled by entrenched
grey between the extreme private- and public-interest
elites and remain secretive about the exact nature of
views.
public policies. Thus, these types of political systems
may be less successful in creating socially efficient
There is also interesting information regarding the
banking regulations than open, competitive, democratFederal Reserve’s role in implementing the Dodd-Frank
ic systems that encourage transparency and penalize
Act. Specifically, McGrane and Hilsenrath (2012) discorruption. As a result, even if one accepts that interest
cuss the far greater role that the Federal Reserve now
groups influence the choice and operation of bank reguplays in bank regulation as compared to earlier years.
lations in an open democracy such as the United States,
They specifically emphasize that the Fed is implementthe degree to which private interests can easily maniping regulations based on the Dodd-Frank Act almost
ulate public policies for their own gain may depend on
completely without public meetings. McGrane and
the organization and operation of political institutions.
Hilsenrath point out that the Fed only held two public
Clearly, a narrow interest group consisting of elites has
meetings after July 2010 as compared to as many as 31
greater control over bank regulations in an autocracy
public meetings a year in the 1980s and 1990s. They
than a democracy.
argue that: “…the Fed’s cloistered approach deprives
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CESifo DICE Report 4/2013 (December)
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Table 1
Number of private meetings with the Federal Reserve by selected big banks
Bank
2010
2011
2012
September 2013
Total
JP Morgan Chase
6
8
13
1
28
Bank of America
6
9
4
0
19
Goldman Sachs
3
7
7
2
19
Morgan Stanley
2
8
5
0
15
Barclays
1
8
1
4
14
Deutsche Bank
1
1
1
4
7
Wells Fargo
4
6
2
0
12
Source: McGrane and Hilsenrath (2012) and Federal Reserve (2013).
Specifically, we use four indicators of the political and
institutional structure in a country to assess whether
differences in structure do indeed influence the choice
of bank regulatory policies. These indicators provide
information about whether each country’s political system and institutional environment tends to favor the private-interest view (or narrowly focused interest groups)
versus the public-interest view (or broadly focused interest groups). Two of the four indicators we use come
from the Polity IV Project (Marshall, Jaggers and Gurr
2011), which provides a database on political regime
characteristics for a broad cross-section of countries,
and the other two come from the International Country
Risk Guide (ICRG). These indicators capture the following characteristics in a country:
In a relatively recent book, Barth et al. (2006) examine
the role that private monitoring, among other factors,
plays in promoting prudent banking behavior. In particular, they argue that the public-interest view predicts
a positive relationship between open, competitive, and
democratic political systems and banking policies that
foster private monitoring. Their empirical work indicates that this type of political and institutional structure
does indeed positively and significantly increase private
monitoring. This means that countries with more open,
competitive, democratic political systems tend to adopt
bank regulatory practices that focus more on information disclosure.
Using a similar approach to Barth et al. (2006), we also
assess the relationship between private monitoring and
selected political and institutional variables. They relied on the World Bank Banking Supervision Survey II
(2003) to construct their measure of private monitoring.
However, we rely on information from the World Bank
Banking Supervision Survey IV (2011) to construct the
same measure of private monitoring. This variable includes information on whether subordinated debt is allowable or required as part of capital, off-balance sheet
items are disclosed to the public, risk management procedures are required to be disclosed to the public, and
formal enforcement actions taken against banks are required to be made public. Moreover, since our purpose
here is only meant to be illustrative, we use a slightly
different set of political and institutional variables in assessing their impact on the private monitoring variable.
If the impact of these and related variables is positive,
we interpret this as meaning any undue influence of narrow interest groups is substantially reduced, if not eliminated. Otherwise, we would expect a negative impact
for these types of variables.
CESifo DICE Report 4/2013 (December)
• Executive Constraints: the extent of formal constraints on the decision-making powers of chief
executives.
• Democracy: the presence of institutions and procedures through which citizens can express effective
preferences about alternative policies and leaders; the
existence of institutionalized constraints on the exercise of power by the executive; and the guarantee of
civil liberties to all citizens in their daily lives and in
acts of political participation.
• Law and Order: the assessment of the strength and
impartiality of the legal system, and the popular observance of the law.
• Bureaucracy Quality: where the bureaucracy has
the strength and expertise to govern without drastic changes in policy or interruptions in government
services.
We choose these indicators because they are likely to exist to a greater degree in countries in which the dominate
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law and private monitoring. It might be noted that Barth
et al. (2009) find that objective court and better law enforcement tend to reduce bank-lending corruption. They
indicate that this is to be expected since bank-lending
corruption is generally related to other illegal activities and the expropriation of creditors’ rights, so that a
well-functioning legal environment helps reduce these
practices. Moreover, in countries where the bureaucracy
has the strength and expertise to govern without drastic
changes in policy or interruptions in government services, we find a strong and positive relationship to private
monitoring. Lastly, however, we do find a positive, but
not robustly significant, relationship between democracy and private monitoring. More generally, consistent
with the public-interest view of regulation, we find that
countries that have the type of political and institutional
characteristics considered here will tend to implement
regulations that require banks to provide accurate information to the private sector. At the same time, this finding is consistent with an environment in which interest
groups that promote only narrow self-interests, rather
than broader public interests, would be limited in unduly influencing bank regulatory policies.
view is the public-interest view. A political and institutional structure in which there are formal constraints on
the decision-making powers of chief executives, citizens can express effective preferences about alternative
policies and leaders, the legal system is impartial and
popularly obeyed, and a strong and expert bureaucracy
is likely to be focused on protecting and promoting the
well-being of the public. The resultant political and institutional system is also likely to put in place bank regulatory policies that do not strictly cater to special interest
groups without regard to the interests of the public.
Table 2 presents our illustrative empirical results indicating the relationship between political and institutional characteristics in a country and private monitoring,
which has been found to be significantly and positively
related to good banking outcomes, by Barth et al. (2006).
We find a significantly, albeit weak, positive relationship
between greater constraints on the chief executive and a
bank regulatory policy that fosters accurate information
disclosure to the public. We also find a significantly, and
again weak, positive relationship between the impartiality of the legal system and popular observance of the
Table 2
Regression results
Political variable
Executive Constraints
Political
variable
Democracy
0.157*
0.088**
0.053
0.237*
0.263*
0.419***
0.299**
(0.075)
(0.083)
(0.038)
(0.040)
(0.126)
(0.137)
(0.106)
(0.141)
Legal origin
- French
Legal origin
- German
1.374***
1.327***
1.296***
1.139***
(0.357)
(0.356)
(0.337)
(0.328)
-0.197
-0.236
-0.047
-0.121
(0.368)
(0.376)
(0.347)
(0.356)
-0.320
-0.302
-0.486
-0.629
(0.324)
Observation
F-test
(p-value)
Bureaucratic Quality
0.196**
Legal origin
- English
Constant
Law and Order
(0.323)
0.362)
(0.397)
6.798***
6.968***
7.290***
7.518***
7.120***
6.751***
7.027***
7.101***
(0.452)
(0.619)
(0.304)
(0.452)
(0.561)
(0.668)
(0.307)
(0.465)
99
67
99
67
91
67
91
67
0.0108
0.0001
0.0236
0.0001
0.063
0.0001
0.0002
0.0001
The dependent variable is the private monitoring index from the World Bank Banking Supervision Survey IV (2011). The
regressions are estimated using the Ordinary Least Squares with robust standard errors. Each of the four political and
institutional variables is entered separately in each regression, with and without dummies for legal origin. The data for
political variables are from 2007, prior to the onset of the financial crisis; therefore, the impact of these institutional variables
is not driven by any change of political institutions as a result of the crisis.
***, **, * indicate the significance levels of 1%, 5% and 10% respectively. The numbers in parentheses are standard errors.
Source: The authors and World Bank Banking Supervision Survey IV (2011).
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CESifo DICE Report 4/2013 (December)
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words, socially efficient regulatory reform that subverts
the narrow interests of special interest groups makes
effective reform extremely challenging. Thus, the research finding that political and institutional systems
substantively shape national bank regulatory policies
implies that successfully implementing banking sector
reform requires a full appreciation of the political and
institutional differences between countries.
The dependent variable is the private monitoring index
from the World Bank Banking Supervision Survey IV
(2011). The regressions are estimated using the Ordinary
Least Squares with robust standard errors. Each of the
four political and institutional variables is entered separately in each regression, with and without dummies
for legal origin. The data for political variables are from
2007, prior to the onset of the financial crisis; therefore,
the impact of these institutional variables is not driven
by any change of political institutions as a result of the
crisis.
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